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PETITIONER: THE COMMISSIONER OF INCOME-TAX,BOMBAY CITY, BOMBAY

       Vs.

RESPONDENT: BIPINCHANDRA MAGANLAL AND CO.  LTD.,BOMBAY

DATE OF JUDGMENT: 17/11/1960

BENCH: SHAH, J.C. BENCH: SHAH, J.C. DAS, S.K. HIDAYATULLAH, M.

CITATION:  1961 AIR 1040            1961 SCR  (2) 493  CITATOR INFO :  R          1965 SC1977  (11)  RF         1966 SC 870  (11)  R          1973 SC1034  (21)  F          1977 SC 560  (7)  R          1978 SC1099  (4,7)

ACT: Income-tax-Profit and assessable income-Difference between -Smallness of profit--How determined-Indian Income-tax Act, 1922 (11 of 1922), SS.  10 (2) (VII) second proviso, 66(1).

HEADNOTE: The  respondent company purchased certain machinery for  Rs. 89,000  and sold it for the same value, but in the books  of account the written down value of the machinery was shown in the  year of account as Rs. 73,392.  The Income Tax  Officer in computing the assessable income of the company added  the difference,  i.e. Rs. 15,608, between the actual  value  and the  written down value to the profit of the  company.   The Income Tax Officer also passed an order under S. 23A of  the Income Tax Act, and directed that the undistributed  portion of  the  assessable  income, shall be deemed  to  have  been distributed  amongst the shareholders as dividend.   Appeals against   the  order  of  the  Income-tax   Officer   proved unsuccessful   and  the  Appellate  Tribunal  referred   the following question to the High Court under s. 66(1):- "Whether the sum of Rs. 15,608 should have been included  in the  assessee company’s "profit" for the purpose  of  deter- mining  whether the payment of a larger dividend  than  that declared by it would be unreasonable." The  High Court answered the question in the  negative.   On appeal by special leave, Held, that the view taken by the High Court was correct. 494 By  the fiction in S. 10(2)(Vii) second proviso,  read  with s.2(6C),  what is really not income is, for the  purpose  of computation  of assessable income, made taxable income:  but on  that account, it does not become commercial profit,  and if it is not commercial profit, it is not liable to be taken into  account in assessing whether in view of the  smallness of profits a larger dividend would be unreasonable.

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"Smallness of profit" should not be equated with  "smallness of assessable income" but should be determined in accordance with commercial principles. Sir  Kasturchand Ltd. v. Commissioner of Income-tax,  Bombay City, (1949) XVII I.T.R. 493, Ezra Proprietary Estates  Ltd. v.  Commissioner  of Income-tax, West Bengal,  (1950)  XVIII I.T.R. 762 and Commissioner of Income-tax Bombay City v.  F. L.  Smith  &  Co. (Bombay) Ltd.,  (1959)  XXXV  I.T.R.  183, referred to.

JUDGMENT: CIVIL APPELLATE JURISDICTION: Civil Appeal No. 761 of 1957. Appeal  by special leave from the judgment and  order  dated February 24, 1955, of the former Bombay High Court in I.T.R. 48/X of 1954. Hardayal Hardy and D. Gupta, for the appellant. N.   A. Palkhivala and I. N. Shroff, for the respondent. 1960.  November 17.  The Judgment of the Court was delivered by SHAH,  J.-The  Income Tax Appellate Tribunal,  Bombay  Bench "A",  referred under s. 66(1) of the Indian Income Tax  Act, 1922-hereinafter  referred  to  as  the  Act-the   following question: "Whether the sum of Rs. 15,608 should have been included  in the   assessee  Company’s  "profit"  for  the   purpose   of determining  whether the payment of a larger  dividend  than that declared by it would be unreasonable ?" The  High  Court  answered the  question  in  the  negative. Against  the  order of the High Court,  with  special  leave under   Art.  136  of  the  Constitution,  this  appeal   is preferred. M/s.  Bipinchandra Maganlal & Co., Ltd.-hereinafter referred to  as the Company-is registered under the Indian  Companies Act, The Company is one in 495 which the public are not substantially interested within the meaning  of  s.  23A Explanation of the  Act.   Its  paid-up capital  at  the  material time was Rs. 20,800  made  up  as follows: 20  shares of Rs. 50 each fully paid up and 1980  shares  of Rs. 50 each, Rs. 10 being paid up per share. In  December 1945, the Company purchased  certain  machinery for Rs. 89,000 and sold it sometime in March, 1947, for  the price  for which it was originally purchased.  In the  books of  account  of the Company, the written down value  of  the machinery  in the year of account 1946-47 (April 1, 1946  to March 31, 1947) was Rs. 73,392.  The trading profits of  the Company  as disclosed by its books of account for  the  year 194647  were  Rs. 33,245.  At the General  Meeting  held  on October  21,  1947. the Company declared a dividend  of  Rs. 12,000  for the year of account.  In assessing tax  for  the year of assessment 1947-48, the Income Tax Officer  computed the assessable income of the Company for the year of account 1946-47 at Rs. 48,761 after adding back to the profit of Rs. 33,245  returned  by  the Company, Rs.  15,608  realised  in excess  of the written down value of the machinery  sold  in March,  1947.  The Income Tax Officer passed an order  under s.  23A of the Act that Rs. 15,429 (being the  undistributed portion  of the assessable income of the Company as  reduced by  taxes payable) shall be deemed to have been  distributed as  dividend amongst the shareholders as at the date of  the General  Meeting,  and  the  proportionate  share  of   each shareholder shall be included in his total income.   Appeals

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preferred  against  his  order to  the  Appellate  Assistant Commissioner  and the Income Tax Appellate  Tribunal  proved unsuccessful, but the Appellate Tribunal at the instance  of the  Company referred the question set out  hereinbefore  to the High Court at Bombay under a.  66(1) of the Act. Section  23A(1) of the Act as it stood at the relevant  time (in so far as it is material) was as follows: "Where  the Income Tax Officer is satisfied that in  respect of  any previous year the profits and gains  distributed  as dividends by any company upto the end 496 of the sixth month after its accounts for that previous year are laid before the company in general meeting are less than 60% of the assessable income of the company of that previous year,  as reduced by the amount of income-tax and  super-tax payable by the company in respect thereof, he shall,  unless he is satisfied that having regard to losses incurred by the company  in earlier years or to the smallness of the  profit made,  the payment of a dividend or a larger  dividend  than that declared would be unreasonable, make with the  previous approval  of the Inspecting Assistant Commissioner an  order in writing that the undistributed portion of the  assessable income of the company of that previous year as computed  for income-tax purposes and reduced by the amount of  income-tax and  super-tax  payable by the company  in  respect  thereof shall  be  deemed  to have  been  distributed  as  dividends amongst  the  share-holders as at the date  of  the  general meeting aforesaid.............. Clearly,  by s. 23A, the Income Tax Officer is  required  to pass  an order directing that the undistributed  portion  of the  assessable income of any company (in which  the  public are  not substantially interested) shall be deemed  to  have been distributed as dividends amongst the shareholders if he is satisfied that (i) the company has not distributed 60% of its  assessable income of the previous year reduced  by  the Income-tax  and super-tax payable, (ii) unless payment of  a dividend,  or a larger dividend than that  declared,  having regard to (a) losses incurred by the company in the  earlier years  or  (b)  the smallness of the  profits  made  in  the previous year, be unreasonable.  The total assessable income of  the Company for the year of account was Rs.  48,761  and the  tax payable thereon was Rs. 21,332: 60% of  Rs.  27,249 (assessable  income reduced by the income tax and  super-tax due) exceeded the dividend declared by Rs. 4,458.  The first condition to the exercise of jurisdiction by the Income  Tax Officer  under S. 23A was therefore indisputably  fulfilled. But the Income Tax Officer had 497 still to be satisfied whether having regard to the smallness of  the profit (there is no evidence in this case that  loss was  incurred by the Company in earlier years), it would  be unreasonable to distribute dividend larger than the dividend actually declared.  The Income Tax Officer did not expressly consider  this  question:  he rested  his  decision  on  the rejection  of the contention raised by the Company that  the difference  between the price of the machinery  realised  by sale and the written down value in the year of account could not be    taken  into account in passing an order  under  S. 23A.  He, it seems, assumed that if that difference be taken into  account,  distribution  of  larger  dividend  was  not unreasonable,  and the Tribunal proceeded upon  the  footing that the assumption was correctly made. Counsel  for  the Revenue submits in support of  the  appeal that  the expression " smallness of profit " means  no  more than  smallness  of the assessable income, and that  in  any

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event, in the computation of profits, the amount realised by sale  of the machinery in the year of account in  excess  of its  written  down  value  was  liable  to  be  included  in considering whether the condition relating to "smallness  of profit" was fulfilled. At  the material time, s. 2(6C) of the Act defined  "income" as inclusive amongst others of any sum deemed to be  profits under  the second proviso to cl. (vii) of sub-s. (2)  of  s. 10.  By s. 10, in the computation of profits or gains of  an assessee  under  the head "Profits and  gains  of  business, profession  or  vocation" carried on by him, the  amount  by which  the written down value of any building, machinery  or plant  which  has  been sold, discarded  or  demolished.  or destroyed  exceeds  the  amount  for  which  the   building, machinery or plant is actually sold or its scrap value is to be  allowed  as  a deduction.   This  allowance  is  however subject to an exception prescribed by the second proviso  to el.  (vii)  sub-s. (2) of s. 10 that where  the  amount  for which  any building, machinery or plant is sold exceeds  the written down value, so much of the 63 498 excess  as  does  not  exceed  the  difference  between  the original cost and the written down value shall be deemed  to be profit of the previous year in which the sale took place. In  computing the profits and gains of the Company under  s. 10  of  the Act, for the purpose of  assessing  the  taxable income, the difference between the written down value of the machinery  in the year of account and the price at which  it was  sold  (the price not being in excess  of  the  original cost) was to be deemed to be profit in the year of  account, and  being such profit, it was liable to be included in  the assessable  income in the year of assessment.  But  this  is the  result  of a fiction introduced by the  Act.   What  in truth  is a capital return is by a fiction regarded for  the purposes  of  the Act as income.   Because  this  difference between  the price realized and the written. down  value  is made chargeable to income tax, its character is not altered, and  it  is  not  converted  into  the  assessee’s  business profits.  It does not reach the assessee as his profits:  it reaches  him  as part of the capital invested  by  him,  the fiction   created   by   s.   10(2)(vii)   second    proviso notwithstanding.   The reason for introducing  this  fiction appears  to  be this.  Where in the previous years,  by  the depreciation  allowance, the taxable income is  reduced  for those  years  and ultimately the asset fetches  on  sale  an amount exceeding the written down value, i.e., the  original cost  less depreciation allowance, the Revenue is  justified in  taking  back what it had allowed in  recoupment  against wear  and  tear, because in fact the  depreciation  did  not result.  But the reason of the rule does not alter the  real character  of  the receipt.  Again, it  is  the  accumulated depreciation  over  a number of years which is  regarded  as income  of  the  year  in which  the  asset  is  sold.   The difference  between the written down value of an  asset  and the price realized by sale thereof though not profit  earned in the conduct of the business of the assessee is nationally regarded  as profit in the year in which the asset is  sold, for the purpose of taking back what had been allowed in  the earlier years. A company normally distributes dividends out of its business profits and not out of its assessable income. 499 There is no definable relation between the assessable income and the profits of a business concern in a commercial sense.

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Computation  of income for purposes of assessment of  income tax is based on a variety of artificial rules and takes into account   several   fictional   receipts,   deductions   and allowances.  In considering whether a larger distribution of dividend  would be unreasonable, the source from  which  the dividend is to be distributed and not the assessable  income has  to  be  taken into account.  The  Legislature  has  not provided  in  s. 23A that in considering  whether  an  order directing that the undistributed profits shall be deemed  to be distributed, the smallness of the assessable income shall be  taken  into  account.   The test  whether  it  would  be unreasonable  to  distribute  a larger dividend  has  to  be adjudged in the light of the profit of the year in question. Even though the assessable income of a company may be large, the  commercial  profits  may be so  small  that  compelling distribution  of the difference between the balance  of  the assessable  income  reduced  by the taxes  payable  and  the amount distributed as dividend would require the company  to fall back either upon its reserves or upon its capital which in law it cannot do.  For instance, in the case of companies receiving  income from property, even though tax  is  levied under  s. 9 of the Act on the bona fide annual value of  the property, the actual receipts may be considerably less  than the  annual value and if the test of reasonableness  is  the extent  of  the  assessable income and  not  the  commercial profit, there may frequently arise cases in which  companies may  have  to sell off their income producing  assets.   The Legislature has deliberately used the expression  "smallness of  profit"  and not "smallness of  assessable  income"  and there  is  nothing in the context in  which  the  expression "smallness of profit" occurs which justifies equation of the expression "profit" with "assessable income".  Smallness  of the  profit  in s. 23A has to be adjudged in  the  light  of commercial  principles  and  not  in  the  light  of   total receipts,  actual or fictional.  This view appears  to  have been  taken  by  the  High  Courts  in  India  without   any dissentient 500 opinion, see Sir Kasturchand Ltd. v. Commissioner of  Income Tax,  Bombay  City  (1), Ezra Proprietary  Estates  Ltd.  v. Commissioner of Income Tax, West Bengal (2) and Commissioner of  income Tax, Bombay City  v. F. L. Smith & Co.,  (Bombay) Ltd. (3). By the fiction in s. 10(2)(vii) second proviso, read with s. 2(6C),  what  is really not income is, for  the  purpose  of computation  of assessable income, made taxable income:  but on  that account, it does not become commercial profit,  and if it is not commercial profit, it is not liable to be taken into  account in assessing whether in view of the  smallness of profits a larger dividend would be unreasonable.  In  our judgment,  the  High  Court was right in  holding  that  the amount of Rs. 15,608 was not liable to be taken into account in considering whether having regard to the smallness of the profit  made  by the Company, it would  be  unreasonable  to declare a larger dividend. The appeal therefore fails and is dismissed with costs.                                       Appeal dismissed. (1) (1940) XVII I.T.R. 493. (2) (1950) XVIII I.T.R. 762. (3) (1959) XXXV I.T.R. 183. 501